An investment in the common stock involves a number of risks, some ofwhich, including market, liquidity, credit, operational, legal and regulatoryrisks, could be substantial and are inherent in our businesses. You shouldcarefully consider the following information about these risks, together withthe other information in this prospectus, before buying shares of commonstock.
As an investment banking and securities firm, our businesses arematerially affected by conditions in the financial markets and economicconditions generally, both in the United States and elsewhere around the world.The equity and debt markets in the United States and elsewhere have achievedrecord or near record levels, and this favorable business environment will notcontinue indefinitely. In the event of a market downturn, our businesses couldbe adversely affected in many ways, including those described below. Ourrevenues are likely to decline in such circ*mstances and, if we were unable toreduce expenses at the same pace, our profit margins would erode. For example,in the second half of fiscal 1998, we recorded negative net revenues from ourTrading and Principal Investments business and from mid-August to mid-Octoberthe number of equity underwritings and announced mergers and acquisitionstransactions in which we participated declined substantially due to adverseeconomic and market conditions. See "Management's Discussion and Analysis ofFinancial Condition and Results of Operations Business Environment" for adiscussion of the market environment in which we operated during that period.Even in the absence of a market downturn, we are exposed to substantial risk ofloss due to market volatility.
We May Incur Significant Losses from Our Trading and InvestmentActivities Due to Market Fluctuations and Volatility
We generally maintain large trading and investment positions in thefixed income, currency, commodity and equity markets. To the extent that we ownassets, i.e., have long positions, in any of those markets, a downturn inthose markets could result in losses from a decline in the value of those longpositions. Conversely, to the extent that we have sold assets we do not own,i.e., have short positions, in any of those markets, an upturn in thosemarkets could expose us to potentially unlimited losses as we attempt to coverour short positions by acquiring assets in a rising market. We may from time totime have a trading strategy consisting of holding a long position in one assetand a short position in another, from which we expect to earn revenues based onchanges in the relative value of the two assets. If, however, the relative valueof the two assets changes in a direction or manner that we did not anticipate oragainst which we are not hedged, we might realize a loss in those pairedpositions. We incurred significant losses in our Trading and PrincipalInvestments business in the second half of fiscal 1998 from this type of"relative value" trade. See "Management's Discussion and Analysis of FinancialCondition and Results of Operations Business Environment" for a discussionof those losses and the market environment in which we operated during thatperiod. In addition, we maintain substantial trading positions that can beadversely affected by the level of volatility in the financial markets,i.e., the degree to which trading prices fluctuate over a particularperiod, in a particular market, regardless of market levels.
Our Investment Banking Revenues May Decline in Adverse Market or EconomicConditions
Unfavorable financial or economic conditions would likely reduce thenumber and size of transactions in which we provide underwriting, mergers andacquisitions advisory and other services. Our Investment Banking revenues, inthe form of financial advisory and underwriting fees, are directly related tothe number and size of the transactions in which we participate and wouldtherefore be adversely affected by a sustained market downturn. In particular,our results of operations would be adversely affected by a significant reductionin the number or size of mergers and acquisitions transactions.
We May Generate Lower Revenues from Commissions and Asset Management
Fees in a Market Downturn
A market downturn could lead to a decline in the volume of transactionsthat we execute for our customers and, therefore, to a decline in the revenueswe receive from commissions and spreads. In addition, because the fees that wecharge for managing our clients' portfolios are in many cases based on the valueof those portfolios, a market downturn that reduces the value of our clients'portfolios or increases the amount of withdrawals would reduce the revenue wereceive from our asset management business.
Holding Large and Concentrated Positions May Expose Us to LargeLosses
Concentration of risk in the past has increased the losses that we haveincurred in our arbitrage, market-making, block trading, underwriting andlending businesses and may continue to do so in the future. Goldman Sachs hascommitted substantial amounts of capital to these businesses, which oftenrequire Goldman Sachs to take large positions in the securities of a particularissuer or issuers in a particular industry, country or region. Moreover, thetrend in all major capital markets is towards larger and more frequentcommitments of capital in many of these activities. For example, as describedunder "Business Trading and Principal Investments Equities", we areexperiencing an increase in the number and size of block trades that we execute,and we expect this trend to continue.
Our Hedging Strategies May Not Prevent Losses
If any of the variety of instruments and strategies we utilize to hedgeour exposure to various types of risk are not effective, we may incur losses.Many of our strategies are based on historical trading patterns andcorrelations. For example, if we hold a long position in an asset, we may hedgethis position by taking a short position in an asset where the short positionhas, historically, moved in a direction that would offset a change in value inthe long position. However, these strategies may not be fully effective inmitigating our risk exposure in all market environments or against all types ofrisk. We have often hedged our exposure to corporate fixed income securities bytaking a short position in U.S. Treasury securities, since historically thevalue of U.S. Treasury securities has changed in a manner similar to changes inthe value of corporate fixed income securities. Due to the move by investors tohigher credit quality fixed income securities in mid-August to mid-October 1998,however, the prices for corporate fixed income securities declined while theprices for U.S. Treasury securities increased and, as a result, we incurredlosses on both positions. Unexpected market developments also affected otherhedging strategies during this time, and unanticipated developments could impactthese or different hedging strategies in the future. See "Management'sDiscussion and Analysis of Financial Condition and Results ofOperations Risk Management" for a discussion of the policies and procedureswe use to identify, monitor and manage the risks we assume in conducting ourbusinesses and of refinements we have made to our riskmanagement policies and procedures as a result of our recent experience.
A Prolonged Market Downturn Could Impair Our Operating Results
While we encountered extremely difficult market conditions inmid-August to mid-October 1998, the financial markets rebounded late in thefourth quarter of fiscal 1998. At some time in the future, there may be a moresustained period of market decline or weakness that will leave us operating in adifficult market environment and subject us to the risks that we describe inthis section for a longer period of time.
Market Risk May Increase the Other Risks That We Face
In addition to the potentially adverse effects on our businessesdescribed above, market risk could exacerbate other risks that we face. Forexample, if we incur substantial trading losses, our need for liquidity couldrise sharply while our access to liquidity could be impaired. In addition, inconjunction with a market downturn, our customers and counterparties could incursubstantial losses of their own, thereby weakening their financial condition andincreasing our credit risk to them. Our liquidity risk and credit risk aredescribed below.
We have devoted significant resources to develop our risk managementpolicies and procedures and expect to continue to do so in the future.Nonetheless, our policies and procedures to identify, monitor and manage risksmay not be fully effective. Some of our methods of managing risk are based uponour use of observed historical market behavior. As a result, these methods maynot predict future risk exposures, which could be significantly greater than thehistorical measures indicate. For example, the market movements of the latethird and early fourth quarters of fiscal 1998 were larger and involved greaterdivergences in relative asset values than we anticipated. This caused us toexperience trading losses that were greater and recurred more frequently thansome of our risk measures indicated were likely to occur. See "Management'sDiscussion and Analysis of Financial Condition and Results ofOperations Business Environment" for a discussion of the market environmentin which we operated during the second half of fiscal 1998 and " RiskManagement" for a discussion of the policies and procedures we use to identify,monitor and manage the risks we assume in conducting our businesses and ofrefinements we have made to our risk management policies and procedures as aresult of our recent experience.
Other risk management methods depend upon evaluation of informationregarding markets, clients or other matters that is publicly available orotherwise accessible by Goldman Sachs. This information may not in all cases beaccurate, complete, up-to-date or properly evaluated. Management of operational,legal and regulatory risk requires, among other things, policies and proceduresto record properly and verify a large number of transactions and events, andthese policies and procedures may not be fully effective.
Liquidity, i.e., ready access to funds, is essential to ourbusinesses. In addition to maintaining a cash position, we rely on threeprincipal sources of liquidity: borrowing in the debt markets; access to therepurchase and securities lending markets; and selling securities and otherassets. See "Management's Discussion and Analysis of Financial Condition andResults of Operations Liquidity" for a discussion of our sources ofliquidity.
An Inability to Access the Debt Capital Markets Could Impair OurLiquidity
We depend on continuous access to the debt capital markets to financeour day-to-day operations. An inability to raise money in the long-term orshort-term debt markets, or to engage in repurchase agreements or securitieslending, could have a substantial negative effect on our liquidity. Our accessto debt in amounts adequate to finance our activities could be impaired byfactors that affect Goldman Sachs in particular or the financial servicesindustry in general. For example, lenders could develop a negative perception ofour long-term or short-term financial prospects if we incurred large tradinglosses, if the level of our business activity decreased due to a marketdownturn, if regulatory authorities took significant action against us or if wediscovered that one of our employees had engaged in serious unauthorized orillegal activity. Our ability to borrow in the debt markets also could beimpaired by factors that are not specific to Goldman Sachs, such as a severedisruption of the financial markets or negative views about the prospects forthe investment banking, securities or financial services industriesgenerally.
We also depend on banks to finance our day-to-day operations. As aresult of the recent consolidation in the banking industry, some of our lendershave merged or consolidated with other banks and financial institutions. Whilewe have not been materially adversely affected to date, it is possible thatfurther consolidation could lead to a loss of a number of our key bankingrelationships and a reduction in the amount of credit extended to us.
An Inability to Access the Short-Term Debt Markets Could Impair OurLiquidity
We depend on the issuance of commercial paper and promissory notes as aprincipal source of unsecured short-term funding for our operations. As ofFebruary 26, 1999, Goldman Sachs had $21.63 billion of outstanding commercialpaper and promissory notes with a weighted-average maturity of approximately 75days. Our liquidity depends to an important degree on our ability to refinancethese borrowings on a continuous basis. Investors who hold our outstandingcommercial paper and promissory notes have no obligation to purchase newinstruments when the outstanding instruments mature.
Our Liquidity Could Be Adversely Affected If Our Ability to Sell AssetsIs Impaired
If we were unable to borrow in the debt capital markets, we would needto liquidate assets in order to meet our maturing liabilities. In certain marketenvironments, such as times of market volatility or uncertainty, overall marketliquidity may decline. In a time of reduced liquidity, we may be unable to sellsome of our assets, or we may have to sell assets at depressed prices, whichcould adversely affect our results of operations and financial condition.
Our ability to sell our assets may be impaired by other marketparticipants seeking to sell similar assets into the market at the same time. Inthe late third and early fourth quarters of fiscal 1998, for example, themarkets for some assets were adversely affected by simultaneous attempts by anumber of institutions to sell similar assets.
A Reduction in Our Credit Ratings Could Adversely Affect Our Liquidityand Competitive Position and Increase Our Borrowing Costs
Our borrowing costs and our access to the debt capital markets dependsignificantly on our credit ratings. These ratings are assigned by ratingagencies, which may reduce or withdraw their ratings or place Goldman Sachs on"credit watch" with negative implications at any time. Credit ratings are alsoimportant to Goldman Sachs when competing in certain markets and when seeking toengage in longer-term transactions, includingover-the-counter derivatives. A reduction in our credit ratings could increaseour borrowing costs and limit our access to the capital markets. This, in turn,could reduce our earnings and adversely affect our liquidity. See "Management'sDiscussion and Analysis of Financial Condition and Results ofOperations Liquidity Credit Ratings" for additional informationconcerning our credit ratings.
We are exposed to the risk that third parties that owe us money,securities or other assets will not perform their obligations. These partiesinclude our trading counterparties, customers, clearing agents, exchanges,clearing houses and other financial intermediaries as well as issuers whosesecurities we hold. These parties may default on their obligations to us due tobankruptcy, lack of liquidity, operational failure or other reasons. This riskmay arise, for example, from holding securities of third parties; entering intoswap or other derivative contracts under which counterparties have long-termobligations to make payments to us; executing securities, futures, currency orcommodity trades that fail to settle at the required time due to non-delivery bythe counterparty or systems failure by clearing agents, exchanges, clearinghouses or other financial intermediaries; and extending credit to our clientsthrough bridge or margin loans or other arrangements. See "Management'sDiscussion and Analysis of Financial Condition and Results ofOperations Risk Management Credit Risk" for a further discussion ofthe credit risks to which we are exposed.
We May Suffer Significant Losses from Our Credit Exposures
In recent years, we have significantly expanded our swaps and otherderivatives businesses and placed a greater emphasis on providing credit andliquidity to our clients. As a result, our credit exposures have increased inamount and in duration. In addition, as competition in the financial servicesindustry has increased, we have experienced pressure to assume longer-termcredit risk, extend credit against less liquid collateral and price moreaggressively the credit risks that we take.
Our Clients and Counterparties May Be Unable to Perform Their Obligationsto Us as a Result of Economic or Political Conditions
Country, regional and political risks are components of credit risk, aswell as market risk. Economic or political pressures in a country or region,including those arising from local market disruptions or currency crises, mayadversely affect the ability of clients or counterparties located in thatcountry or region to obtain foreign exchange or credit and, therefore, toperform their obligations to us. See " We Are Exposed to Special Risks inEmerging and Other Markets" for a further discussion of our exposure to theserisks.
Defaults by a Large Financial Institution Could Adversely AffectFinancial Markets Generally and Us Specifically
The commercial soundness of many financial institutions may be closelyinterrelated as a result of credit, trading, clearing or other relationshipsbetween the institutions. As a result, concerns about, or a default by, oneinstitution could lead to significant liquidity problems or losses in, ordefaults by, other institutions. This is sometimes referred to as "systemicrisk" and may adversely affect financial intermediaries, such as clearingagencies, clearing houses, banks, securities firms and exchanges, with which weinteract on a daily basis.
The possibility of default by a major market participant in the secondhalf of fiscal 1998 and concerns throughout the financial industry regarding theresulting impact on markets led us to participate in an industry-wide consortiumthat invested in Long-TermCapital Portfolio, L.P., which is described under "Management's Discussion andAnalysis of Financial Condition and Results ofOperations Liquidity The Balance Sheet". Actual defaults, increases inperceived default risk and other similar events could arise in the future andcould have an adverse effect on the financial markets and on Goldman Sachs.
The Information That We Use in Managing Our Credit Risk May Be Inaccurateor Incomplete
Although we regularly review our credit exposure to specific clientsand counterparties and to specific industries, countries and regions that webelieve may present credit concerns, default risk may arise from events orcirc*mstances that are difficult to detect, such as fraud. We may also fail toreceive full information with respect to the trading risks of a counterparty. Inaddition, in cases where we have extended credit against collateral, we may findthat we are undersecured, for example, as a result of sudden declines in marketvalues that reduce the value of collateral.
Parties May Not Achieve Year 2000 Readiness
Year 2000 Readiness Disclosure
With the year 2000 approaching, many institutions around the world arereviewing and modifying their computer systems to ensure that they are Year 2000compliant. The issue, in general terms, is that many existing computer systemsand microprocessors (including those in non-information technology equipment andsystems) use only two digits to identify a year in the date field with theassumption that the first two digits of the year are always "19". Consequently,on January 1, 2000, computers that are not Year 2000 compliant may read the yearas 1900. Systems that calculate, compare or sort using the incorrect date maymalfunction.
Our Computer Systems May Fail
Because we are dependent, to a very substantial degree, upon the properfunctioning of our computer systems, a failure of our systems to be Year 2000compliant would have a material adverse effect on us. Failure of this kindcould, for example, cause settlement of trades to fail, lead to incomplete orinaccurate accounting, recording or processing of trades in securities,currencies, commodities and other assets, result in generation of erroneousresults or give rise to uncertainty about our exposure to trading risks and ourneed for liquidity. If not remedied, potential risks include businessinterruption or shutdown, financial loss, regulatory actions, reputational harmand legal liability.
The Computer Systems of Third Parties on Which We Depend May Fail
We depend upon the proper functioning of third-party computer andnon-information technology systems. These parties include tradingcounterparties, financial intermediaries such as securities and commoditiesexchanges, depositories, clearing agencies, clearing houses and commercial banksand vendors such as providers of telecommunication services and other utilities.We continue to assess counterparties, intermediaries and vendors with whom wehave important financial or operational relationships to determine the extent oftheir Year 2000 preparedness. We have not yet received sufficient informationfrom all parties about their Year 2000 preparedness to assess the effectivenessof their efforts. Moreover, in many cases, we are not in a position to verifythe accuracy or completeness of the information we receive from third partiesand as a result are dependent on their willingness and ability to disclose, andto address, their Year 2000 problems. In addition, in some international marketsin which we do business, the level of awareness and remediation efforts relatingto the Year 2000 issue may be less advanced than in the United States.
If third parties with whom we interact have Year 2000 problems that arenot remedied, problems could include the following:
- in the case of vendors, disruption of important services upon which Goldman Sachs depends, such as telecommunications and electrical power;
- in the case of third-party data providers, receipt of inaccurate or out-of-date information that would impair our ability to perform critical data functions, such as pricing our securities or other assets;
- in the case of financial intermediaries, such as exchanges and clearing agents, failed trade settlements, inability to trade in certain markets and disruption of funding flows;
- in the case of banks and other lenders, disruption of capital flows potentially resulting in liquidity stress; and
- in the case of counterparties and customers, financial and accounting difficulties for those parties that expose Goldman Sachs to increased credit risk and lost business.
Disruption or suspension of activity in the world's financial markets isalso possible.
Our Revenues May Be Adversely Affected If Market Activity DecreasesShortly Before and After the Year 2000
We believe that uncertainty about the success of remediation effortsgenerally may cause many market participants to reduce the level of their marketactivities temporarily as they assess the effectiveness of these efforts duringa "phase-in" period beginning in late 1999. We believe that lenders are likelyto take similar steps, which will result in a reduction in available fundingsources. Consequently, there may be a downturn in customer and general marketactivity for a short period of time before and after January 1, 2000. If thisoccurs, our net revenues may be adversely affected, possibly materially,depending on how long the reduction in activity continues and how broadly itaffects the markets. In addition, we expect to reduce our own trading activitiesand the size of our balance sheet in order to manage the number and type of ourtransactions that settle during this period and our related funding needs. Thisalso could reduce our net revenues. We cannot predict the magnitude of theimpact that these kinds of reductions would have on our businesses.
We May Be Exposed to Litigation as a Result of Year 2000 Problems
We may be exposed to litigation with our customers and counterpartiesas a result of Year 2000 problems. For example, litigation could arise fromproblems relating to our internal systems or to external systems on which wedepend, as well as from problems involving companies in which our clients or thefunds we manage hold investments.
Our Year 2000 Program May Not Be Effective and Our Estimates of Timingand Cost May Not Be Accurate
Our Year 2000 program may not be effective and our estimates about thetiming and cost of completing our program may not be accurate. For a descriptionof our program and the steps that remain to be taken, see "Management'sDiscussion and Analysis of Financial Condition and Results ofOperations Risk Management Operational and Year 2000 Risks Year2000 Readiness Disclosure".
We face operational risk arising from mistakes made in the confirmationor settlement of transactions or from transactions notbeing properly recorded, evaluated or accounted for. Our businesses are highlydependent on our ability to process, on a daily basis, a large number oftransactions across numerous and diverse markets in many currencies, and thetransactions we process have become increasingly complex. Consequently, we relyheavily on our financial, accounting and other data processing systems. If anyof these systems do not operate properly or are disabled, we could sufferfinancial loss, a disruption of our businesses, liability to clients, regulatoryintervention or reputational damage. The inability of our systems to accommodatean increasing volume of transactions could also constrain our ability to expandour businesses. In recent years, we have substantially upgraded and expanded thecapabilities of our data processing systems and other operating technology, andwe expect that we will need to continue to upgrade and expand in the future toavoid disruption of, or constraints on, our operations.
Substantial legal liability or a significant regulatory action againstGoldman Sachs could have a material financial effect or cause significantreputational harm to Goldman Sachs, which in turn could seriously harm ourbusiness prospects.
Our Exposure to Legal Liability Is Significant
We face significant legal risks in our businesses and the volume andamount of damages claimed in litigation against financial intermediaries areincreasing. These risks include potential liability under securities or otherlaws for materially false or misleading statements made in connection withsecurities and other transactions, potential liability for the "fairnessopinions" and other advice we provide to participants in corporate transactionsand disputes over the terms and conditions of complex trading arrangements. Wealso face the possibility that counterparties in complex or risky tradingtransactions will claim that we improperly failed to tell them of the risks orthat they were not authorized or permitted to enter into these transactions withus and that their obligations to Goldman Sachs are not enforceable. Particularlyin our rapidly growing business focused on high net worth individuals, we areincreasingly exposed to claims against Goldman Sachs for recommendinginvestments that are not consistent with a client's investment objectives orengaging in unauthorized or excessive trading. During a prolonged marketdownturn, we would expect these types of claims to increase. We are also subjectto claims arising from disputes with employees for alleged discrimination orharassment, among other things. These risks often may be difficult to assess orquantify and their existence and magnitude often remain unknown for substantialperiods of time. We incur significant legal expenses every year in defendingagainst litigation, and we expect to continue to do so in the future. See"Business Legal Matters" for a discussion of some of the legal matters inwhich we are currently involved.
Extensive Regulation of Our Businesses Limits Our Activities and MaySubject Us to Significant Penalties
The financial services industry is subject to extensive regulation.Goldman Sachs is subject to regulation by governmental and self-regulatoryorganizations in the United States and in virtually all other jurisdictions inwhich it operates around the world.
The requirements imposed by our regulators are designed to ensure theintegrity of the financial markets and to protect customers and other thirdparties who deal with Goldman Sachs and are not designed to protect ourshareholders. Consequently, these regulations often serve to limit ouractivities, including through net capital, customer protection and marketconduct requirements. We face the risk of significant intervention by regulatoryauthorities, including extended investigation and surveillance activity,adoptionof costly or restrictive new regulations and judicial or administrativeproceedings that may result in substantial penalties. Among other things, wecould be fined or prohibited from engaging in some of our business activities.See "Business Regulation" for a further discussion of the regulatoryenvironment in which we conduct our businesses.
Legal Restrictions on Our Clients May Reduce the Demand for OurServices
New laws or regulations or changes in enforcement of existing laws orregulations applicable to our clients may also adversely affect our businesses.For example, changes in antitrust enforcement could affect the level of mergersand acquisitions activity and changes in regulation could restrict theactivities of our clients and, therefore, the services we provide on theirbehalf.
There have been a number of highly publicized cases involving fraud orother misconduct by employees in the financial services industry in recentyears, and we run the risk that employee misconduct could occur. Misconduct byemployees could include binding Goldman Sachs to transactions that exceedauthorized limits or present unacceptable risks, or hiding from Goldman Sachsunauthorized or unsuccessful activities, which, in either case, may result inunknown and unmanaged risks or losses. Employee misconduct could also involvethe improper use or disclosure of confidential information, which could resultin regulatory sanctions and serious reputational or financial harm. It is notalways possible to deter employee misconduct and the precautions we take toprevent and detect this activity may not be effective in all cases.
The financial services industry and all of our businesses areintensely competitive, and we expect them to remain so. We compete on the basisof a number of factors, including transaction execution, our products andservices, innovation, reputation and price. We have experienced intense pricecompetition in some of our businesses in recent years, such as underwriting feeson investment grade debt offerings and privatizations. We believe we mayexperience pricing pressures in these and other areas in the future as some ofour competitors seek to obtain market share by reducing prices.
We Face Increased Competition Due to a Trend Toward Consolidation
In recent years, there has been substantial consolidation andconvergence among companies in the financial services industry. In particular, anumber of large commercial banks, insurance companies and other broad-basedfinancial services firms have established or acquired broker-dealers or havemerged with other financial institutions. Many of these firms have the abilityto offer a wide range of products, from loans, deposit-taking and insurance tobrokerage, asset management and investment banking services, which may enhancetheir competitive position. They also have the ability to support investmentbanking and securities products with commercial banking, insurance and otherfinancial services revenues in an effort to gain market share, which couldresult in pricing pressure in our businesses.
Consolidation Has Increased Our Need for Capital
This trend toward consolidation and convergence has significantlyincreased the capital base and geographic reach of our competitors. This trendhas also hastened the globalization of the securities and other financialservices markets. As a result, we have had to commit capital to support ourinternational operations and to execute large global transactions.
Our Ability to Expand Internationally WillDepend on Our Ability to Compete Successfully with Local FinancialInstitutions
We believe that some of our most significant challenges andopportunities will arise outside the United States, as described under "Industryand Economic Outlook". In order to take advantage of these opportunities, wewill have to compete successfully with financial institutions based in importantnon-U.S. markets, particularly in Europe. Some of these institutions are larger,better capitalized and have a stronger local presence and a longer operatinghistory in these markets.
Our Revenues May Decline Due to Competition from Alternative TradingSystems
Securities and futures transactions are now being conducted through theInternet and other alternative, non-traditional trading systems, and it appearsthat the trend toward alternative trading systems will continue and probablyaccelerate. A dramatic increase in computer-based or other electronic tradingmay adversely affect our commission and trading revenues, reduce ourparticipation in the trading markets and associated access to market informationand lead to the creation of new and stronger competitors.
In conducting our businesses in major markets around the world,including many developing markets in Asia, Latin America and Eastern Europe, weare subject to political, economic, legal, operational and other risks that areinherent in operating in other countries. These risks range from difficulties insettling transactions in emerging markets to possible nationalization,expropriation, price controls and other restrictive governmental actions. Wealso face the risk that exchange controls or similar restrictions imposed byforeign governmental authorities may restrict our ability to convert localcurrency received or held by us in their countries into U.S. dollars or othercurrencies, or to take those dollars or other currencies out of thosecountries.
To date, a relatively small part of our businesses has been conductedin emerging and other markets. As we expand our businesses in these areas, ourexposure to these risks will increase.
Turbulence in Emerging Markets MayAdversely Affect Our Businesses
In the last several years, various emerging market countries haveexperienced severe economic and financial disruptions, including significantdevaluations of their currencies and low or negative growth rates in theireconomies. The possible effects of these conditions include an adverse impact onour businesses and increased volatility in financial markets generally.Moreover, economic or market problems in a single country or region areincreasingly affecting other markets generally. For example, the economic crisisin Russia in August 1998 adversely affected other emerging markets and led toturmoil in financial markets worldwide. See "Management's Discussion andAnalysis of Financial Condition and Results of Operations BusinessEnvironment" for a discussion of the business environment in which we operatedduring the second half of fiscal 1998. A continuation of these situations couldadversely affect global economic conditions and world markets and, in turn,could adversely affect our businesses. Among the risks are regional or globalmarket downturns and, as noted above, increasing liquidity and credit risks,particularly in Japan where the economy continues to be weak and we havesignificant exposure.
Compliance with Local Laws and Regulations May Be Difficult
In many countries, the laws and regulations applicable to thesecurities and financial services industries are uncertain and evolving,and it may be difficult for us to determine the exact requirements of local lawsin every market. Our inability to remain in compliance with local laws in aparticular foreign market could have a significant and negative effect not onlyon our businesses in that market but also on our reputation generally. Theseuncertainties may also make it difficult for us to structure our transactions insuch a way that the results we expect to achieve are legally enforceable in allcases. See " Legal and Regulatory Risks Are Inherent and Substantial in OurBusinesses Our Exposure to Legal Liability Is Significant" for additionalinformation concerning these matters and "Business Regulation" for adiscussion of the regulatory environment in which we conduct our businesses.
Our performance is largely dependent on the talents and efforts ofhighly skilled individuals. Competition in the financial services industry forqualified employees is intense. Our continued ability to compete effectively inour businesses depends on our ability to attract new employees and to retain andmotivate our existing employees.
In connection with the offerings and the conversion of Goldman Sachsfrom partnership to corporate form, the managing directors who were profitparticipating limited partners will receive substantial amounts of common stockin exchange for their interests in Goldman Sachs. Because these shares of commonstock will be received in exchange for partnership interests, ownership of theseshares will not be dependent upon these partners' continued employment. However,these shares will be subject to certain restrictions on transfer under ashareholders' agreement and a portion may be pledged to support these partners'obligations under noncompetition agreements. The transfer restrictions under theshareholders' agreement may, however, be waived, as described under "CertainRelationships and Related Transactions Shareholders'Agreement Transfer Restrictions" and " Waivers". The steps we havetaken to encourage the continued service of these individuals after theofferings may not be effective. For a description of the compensation plan forour senior professionals to be implemented after the offerings, see"Management The Partner Compensation Plan".
In connection with the offerings and conversion of Goldman Sachs frompartnership to corporate form, employees, other than the managing directors whowere profit participating limited partners, will receive grants of restrictedstock units, stock options or interests in a defined contribution plan. Theincentives to attract, retain and motivate employees provided by these awards orby future arrangements may not be as effective as the opportunity, which existedprior to conversion, to become a partner of Goldman Sachs. See"Management The Employee Initial Public Offering Awards" for a descriptionof these awards.
Managing Directors Whose Interests May
Differ from Those of Other Shareholders
Upon completion of the offerings, our managing directors willcollectively own not less than 281,000,000 shares of common stock, or 60% of thetotal shares of common stock outstanding, which includes the shares of commonstock underlying the restricted stock units to be awarded based on a formula.These shares will be subject to a shareholders' agreement, which will providefor coordinated voting by the parties. Further, both Sumitomo Bank CapitalMarkets, Inc. and Kamehameha Activities Association, which together will own43,400,473 shares of common stock, or 9.3% of the total shares of common stockoutstanding after consummation of the offerings, have agreed to vote theirshares of common stock in the same manner as a majority of the shares held byour managing directors are voted. See "Certain Relationships and RelatedTransactions Shareholders' Agreement Voting" and " Voting Agreement" for adiscussion of these voting arrangements.
As a result of these arrangements, the managing directors initiallywill be able to elect our entire board of directors, control the management andpolicies of Goldman Sachs and, in general, determine, without the consent of theother shareholders, the outcome of any corporate transaction or other mattersubmitted to the shareholders for approval, including mergers, consolidationsand the sale of all or substantially all of the assets of Goldman Sachs. Themanaging directors initially will be able to prevent or cause a change incontrol of Goldman Sachs.
Provisions of Our Organizational Documents May Discourage an Acquisitionof Goldman Sachs
Our organizational documents contain provisions that will impede theremoval of directors and may discourage a third party from making a proposal toacquire us. For example, our board of directors may, without the consent ofshareholders, issue preferred stock with greater voting rights than the commonstock. See "Description of Capital Stock Certain Anti-Takeover Matters" fora discussion of these anti-takeover provisions.
Sales of substantial amounts of common stock, or the possibility ofsuch sales, may adversely affect the price of the common stock and impede ourability to raise capital through the issuance of equity securities. See "SharesEligible for Future Sale" for a discussion of possible future sales of commonstock.
Upon consummation of the offerings, there will be 467,271,909 shares ofcommon stock outstanding. Of these shares, the 69,000,000 shares of common stocksold in the offerings will be freely transferable without restriction or furtherregistration under the Securities Act of 1933. The remaining 398,271,909 sharesof common stock will be available for future sale upon the expiration or thewaiver of transfer restrictions or in accordance with registration rights. See"Shares Eligible for Future Sale" for a discussion of the shares of common stockthat may be sold into the public market in the future.
The price of the common stock after the offerings may fluctuate widely,depending upon many factors, including the perceived prospects of Goldman Sachsand the securities and financial services industries in general, differencesbetween our actual financial and operating results and those expected byinvestors and analysts, changes in analysts' recommendations or projections,changes in general economic or market conditions and broad market fluctuations.The common stock may trade at prices significantly below the initial publicoffering price.
We will list the common stock on the NYSE. The NYSE listing does not,however, guarantee that a trading market for the common stock will develop or,if a market does develop, the liquidity of that market for the common stock.
After the offerings, because Goldman, Sachs & Co. is a member of theNYSE and because of Goldman, Sachs & Co.'s relationship to us, it will not bepermitted under the rules of the NYSE to make markets in, or recommendationsregarding the purchase or sale of, the common stock. This may adversely affectthe trading market for the common stock.
We expect to record a substantial pre-tax loss in the second quarter offiscal 1999 due to a number of nonrecurring items described under "Management'sDiscussion and Analysis of Financial Condition and Results ofOperations Results of Operations".
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